Question

Short Answer Question 4: The following table provides cash flow estimates associated with a projected capital investment. Assuming a cost of capital of 15%, calculate and interpret the NPV, IRR and Payback Period for this investment. Discuss whether the capital investment should be accepted or not.

Year Cash Flow

0 (current period) -$80,000

1 $5,000

2 $25,000

3 $50,000

4 $75,000

Answer 1

1) Calcualtion of NPV

Years	Net Cash flows	Discount Factor @15%	Present Value
0	-$80000	1	$-80000
1	$5000	0.8696	$4348
2	$25000	0.7561	$18904
3	$50000	0.6575	$32876
4	$75000	0.5718	$42881
NPV	$19009

Therefore, NPV = $19009

2) CALCULATION OF IRR UNDER TRIAL AND ERROR METHOD.

Years	Cash Flows	Discount Factor @ 25%	Present Value	Discount Factor @ 23%	Present Value
0	-80000	1	-80000.00	1	-80000
1	5000	0.8000	4000.00	0.8130	4065
2	25000	0.6400	16000.00	0.6610	16525
3	50000	0.5120	25600.00	0.5374	26869
4	75000	0.4096	30720.00	0.4369	32767
NPV	-3680.00		226

For 2% change	3906	change in present value
For $226 change in present value	2*226/3906	change in percentage
		=	0.12	change in percentage
Therefore, 23.12% is the required IRR

3) CALCULATION OF PAYBACK PERIOD.

Years	Cash Flows	Cumulative Cash flow
0	-$80,000.00	-$80,000.00
1	$5,000.00	-$75,000.00
2	$25,000.00	-$50,000.00
3	$50,000.00	$0.00
4	$75,000.00	$75,000.00

Therefore, Payback period is 3 years since the cumulative cash flow becomes Zero.

Therefore, the project should be accepted.